Depending on whom you ask, the current stock market is either
too expensive and headed for a further fall, or too cheap and
poised for a rebound. The issue is irrelevant. The real question
involves specific stocks -- not the broader market. This is
because, in these challenging times, some can look vulnerable,
while others look like once-in-a-decade bargains.
I had no idea how cheap many stocks had become until I ran a screen
seeking out strong
free cash flow
yielders. These are companies that look inexpensive in relation to
their underlying free cash flow (which is what's left over after
you deduct capital expenditures from operating
). To get the
, you simply divide the trailing free cash flow by the company's
(market value plus debt minus total cash).
Historically speaking, blue-chip stocks often trade for 20 to 25
times trailing free cash flow. This translates into a free cash
flow yield of 4% or 5% (i.e. 100/25 = 4). With the exception of the
swoon of 2008/2009, we are looking at the only time in the past 40
years when a large number of blue chips actually sport free cash
flow yields of 10% or more. In fact, 77 companies in the S&P
500 trade at such unusually low valuations, with 31 of them
sporting free cash flow yields of 14% or higher. This is pretty
amazing in an era when traditional "yield plays" such as
and certificates of deposit (
) offer yields below 3%.
Each of the companies in the table below sport free cash flow
yields above 20%.
Of course, free cash flow looked pretty impressive for many
companies in 2010, but it might suffer in 2011 and 2012 if
theeconomy falls intorecession . So I've pared the list of high
free cash flow yielders to exclude any company that saw a sharp
drop in free cash flow in 2008 or 2009. Deeply cyclical companies
are unlikely to attract value investors -- at least until we have a
clearer read that a weak
won't pressure cash flows anew.
Each of the companies in the table below trade for less than eight
times "trough" free cash flow (i.e. the worst free cash flow
showing in any of the past four years). This translates into free
cash flow yields in excess of 12.5%.
Notably, there's no thematic trend with this group. You have
struggling retailers such as
The Gap (NYSE:
, beleaguered publishers like
and technology giants such as
Cisco Systems (Nasdaq:
. All of these firms have been hard-pressed to boost sales in
recent years (which explain why theirshares have been so cheap) but
in fact, they are all free cash flow powerhouses.
But some of these stocks face real long-term threats.
Western Digital (NYSE:
, for example, may see its sales slide when traditional hard disk
drives (HDDs) lose
to newer forms of computer storage.
As I noted recently
Micron Technology (NYSE:
would be the clear beneficiaries of such a transition.
The rain-or-shinebusiness model
It's an old axiom that advertising is a very
. But it may not be as cyclical as you think.
, one of the world's largest advertising agencies, still managed to
generate $446 million in free cash flow in 2009, less than the $700
million it bagged in 2008 and 2010, but still quite respectable.
However, fears that the weak economy could lead free cash flow to
evaporate have pushed this stock down 37% in just six weeks.
now trade at an eye-popping five times trailing free cash flow
(good for a 19% free cash flow yield).
Even if results weaken to 2009 levels, shares would still trade for
a hefty 12% free cash flow. And this would be a yield reflected at
the bottom of the economic cycle. Imagine what this yield would
look like when the economy is on a stronger plane.
Much of the credit for the free cash flow generation at Interpublic
goes to a deep restructuring of the business that began in 2006.
From 2003 to 2005, Interpublic looked ill-equipped to address
changing client needs in an increasingly digital universe. So
management sought out new ventures and acquired hotter young ad
agencies while trimming costs.
before interest, taxes,
) margins were flat in the middle of the decade, rose to 3% in
2006, 8% in 2007 and about 10% in 2008.
What about a slowdown? "The advertising model benefits from high
and we think IPG can maintain earnings and cash flow at current
levels in a recessionary dip," note analysts at Albert Fried, who
have a $13 share
-- 30% above current levels.
And what is Interpublic doing with all of its free cash flow? It's
that currently yields 3%, while buying back stock ($140 million in
the first half of 2011). The analysts at Albert Fried say those
stock-boosting moves will continue: "IPG also has plenty of fire
power to fuel share repurchases as the company has $1.8 billion in
cash on its
and a stake in Facebook that can be monetized in the $200-$300
Risks to consider:
Interpublic's free cash flow remained healthy through the
2008-2009 downturn, but a steeper and more sustained slowdown in
the U.S. and European economies could push free cash flow closer to
Action to Take -->
Forget the major stock averages. Instead, stay focused on cheap and
defensive blue chips. These free cash flow generators are likely to
be ports in the storm, especially since many of them are buying
back stock with their prodigious free cash flow. Interpublic is
just one place to look, but there are many more candidates out
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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